Why REIT fast turning into an alternative investment class

Equity as an asset class comes with its set of high risks and volatile earnings. Yes, there is a very large element of multiple returns, but the number of stocks which turn out to be multi-baggers is a low single digit from the universe.

Fixed deposit is another asset class which gives just the coupon rate and at times when the economy does well, fails to return the rising cost of inflation. Real estate comes with its mystique and is an asset class which has high returns but is cyclical, and entry and exit from this investment is a tedious process and above all requires very large investments.

Is there an alternative where one can get the best of almost all? Yes, real estate investment trust (REIT) or real estate investment trust is a product which gives almost everything that one can think of. Readers would be aware that in the calendar year the returns from the benchmark indices in India were sub 5 per cent while returns from Dow and many leading global indices were negative. Interest rates have been rising globally, yet they are in the region of 6.5 per cent in India and 4.75 per cent in the US. A fixed deposit would earn about 7 to 7.5 per cent depending upon the tenure, age of the investor and also amount. There is however no upside to this return in any manner whatsoever.

REIT is a product which has underlying real estate assets as its investments which are yielding rental income from commercial real estate, attached or stand-alone hotel properties and also retail assets like malls. These assets have a steady income in rentals which come up for renewals every three to five years depending on the contracts entered into. They ensure the appreciation or upside that one wants from an investment.

Expenses such as maintenance are added on and are charged on actuals or with an additional fee Take for example the two years of covid where office space was not fully utilised as people worked from home, while rebates were given to occupiers of commercial space, those who moved out and wanted to rehire have paid significantly higher for similar spaces.

When REIT as an asset class was introduced in the markets and available for trading, it was meant for the ultra-rich HNI as the ticket size was large. As time went by and the product became popular, people understood that this is a product meant for an investor and not necessarily the HNI. Looking at the need of the hour, the lot size was reduced and the product is now available for investment of one unit for an amount which is just about Rs 300.

How does the REIT work or generate returns for unit holders? The trust buys real estate assets of which the dominant part, minimum 80 per cent have to be completed and are income generating assets.

Unlike equity issue offerings, the trust gives forward guidance and projections of income and distribution to prospective investors. Income comes from rentals of real estate and other charges like car parking and some common facilities of food courts and such other facilities in commercial areas. There is an upside to all of this as a certain percentage of the total pool of assets comes up for renewal every year. This fetches higher returns to factor in appreciation of real estate, inflation and above all interest rates.

At the end of the day, rent is the sum and substance of real estate price which has demand supply and interest rates as key components. The yield from REIT is in the region of 7.5-8 per cent and varies upon the performance of the fund or the trust and the kind of underlying assets it holds.

Interestingly, land bank and residential houses are excluded form the ambit of REIT. The icing on the cake is the discount to NAV that these instruments trade at. When there is an uptick in demand, the discount narrows which results in substantial capital appreciation as well. The discount to NAV varies from 18-24 per cent. The typical rental increase annually is between 3.5 to 5 per cent which ensures higher distribution.

The distribution to unit holders has to be a minimum of 90 per cent of the net distributable cash flow. This ensures a healthy pay out for unit holders. For the layman investor, he gets an opportunity to do a check on the value of the underlying assets every quarter when the company declares its results and its NAV. This NAV is nothing more than the mark to market value of its asset.

Appreciation in NAV happens when the market value of the property goes up. Every asset of a manufacturing company has a shelf life or life of the plant and equipment. In the case of real estate, land is lifelong and buildings on the same have a life in excess of 35 years. With regular maintenance, this life gets extended and over a longer time span the entire building can be rebuilt.

The trust sells units of the trust to investors and raises capital. With this it invests in buying real estate assets. As a sponsor it may allocate assets to the trust and pay for the same by allotting units to itself. The earnings from a REIT come in three parts as a combination or either or. They are dividend, interest and return of capital.

In conclusion, REIT is an asset which gives better yield than a fixed deposit return, has an upside in real estate appreciation and also reduction in discount to the NAV. There are currently three listed REITs in the form of Mindspace Business Parks, Embassy Office Parks and Brookfield India Real Estate Trust which are traded at the bourses.

(Arun Kejriwal is the founder of Kejriwal Research and Investment Services. The views expressed are personal)